Hello and welcome back to MarketWatch’s Extra Credit column, a weekly look at the news through the lens of debt.
This week, we’re diving into a recent regulatory action surrounding Income Share Agreements — deals companies, schools, nonprofits and other organizations offer students as a way to finance their education.
The agreements, — which allow a student to pledge a portion of their future earnings in exchange for upfront funds to pay tuition — have gained traction in recent years as policymakers and educators grow increasingly concerned about the implications of traditional student debt on borrowers. Proponents of the deals note that they offer insurance for students because borrowers’ incomes typically have to reach a certain threshold before they’re making payments on the agreement.
But ISAs have also sparked concern from consumer advocates and some lawmakers who say that an ISA is just a loan by another name with terms that risk confusing borrowers and calling them something else is just an effort to evade regulation.
Watching the debate play out over the past few years over whether an ISA constitutes a loan is one of the things that pushed me to look more closely in this column (and elsewhere) at the way we talk about debt and credit. It starkly highlights the weight of those terms; the rules these products have to follow hinge in part on whether they’re defined as credit in the eyes of the law, but a major part of their appeal is that they’re pitched as an alternative to student loans.
This week may have marked a turning point in that years-long discussion. So let’s dig into the news and its implications.
CFPB says ISA provider deceived borrowers
The Consumer Financial Protection Bureau found that Better Future Forward, a nonprofit offering ISAs, misled borrowers by telling students that their ISAs weren’t loans and didn’t create debt. The consumer watchdog also found that the organization didn’t follow certain disclosure and other laws that apply to private student loans.
BFF agreed to a consent order with the CFPB without admitting or denying any of the bureau’s findings. As part of the deal, the organization agreed to — among other provisions — stop saying that its ISAs aren’t loans and to provide potential borrowers with certain disclosures required by law for lending products that are meant to make it easier for consumers to evaluate products.
“The Consumer Financial Protection Bureau found that Better Future Forward, a nonprofit offering ISAs, misled borrowers by telling students that their ISAs weren’t loans and didn’t create debt.”
The order only binds BFF, “but it throws down a pretty clear marker about what the CFPB thinks about ISAs,” said Adam Levitin, a professor at Georgetown Law. “It’s a statement that the CFPB believes that ISAs are private student loans,” he said, and are therefore subject to certain laws governing them, like the Truth in Lending Act.
That law requires lenders to inform borrowers of specific provisions of a loan, including the annual percentage rate or APR. “The CFPB in its order was very clear that those disclosures need to be made by BFF,” said Maria Earley, a partner at Morrison and Foerster, who advises and represents fintech and financial services companies.
As a result of the order some ISA providers may also rethink their approach to payment caps, said Heather Klein, an attorney at Ballard Spahr, who advises financial services companies on regulatory and enforcement issues. Typically students pay back ISAs one of two ways: Either by paying a percentage of their income for a certain period of time or by paying back a certain amount of money, what’s known in the industry as a payment cap on the ISA.
The CFPB found that Better Future Forward’s payment cap structure violated a ban on prepayment penalties for private student loans because in one of its programs, the organization automatically added 10% of the funding amount if the student wanted to repay the ISA early.
“This may portend a significant shift in ISA programs that set the payment cap as a multiple of the funding amount,” Klein said.
The intent behind setting the payment cap as a fixed multiple of the original funding amount is to allow a high earner to exit the ISA early, but still ensure that they repay enough to subsidize returns from low or moderate earners. Providers may need to redesign their payment caps to comply with the CFPB’s order yet do so in a way that their ISA programs remain sustainable, Klein said.
Violation of Truth in Lending Act requirements
In the case of Better Future Forward, the organization offered two income-share agreements with financing up to $2,500 or up to $35,000, depending on the program. Students could satisfy their end of the deal in one of two ways, according to the CFPB order. In the first, students would pay back a portion of their income for a set period of time. If students’ post-graduation income fell below a certain threshold, then they would have a monthly payment of zero.
Students’ second option was to pay back a set amount of money, known as a payment cap on the agreement. Better Future Forward determined the amount of the payment cap by taking a base number and adding what the organization called a “growth component” or percentage of the base number, according to the CFPB order.
For one of the ISAs offered by BFF, the organization calculated the base for the payment cap by immediately adding 10% to the amount funded, which, according to the CFPB, constituted a prepayment fee or penalty, in violation of Truth in Lending Act requirements for private educational lenders.
CFPB officials also wrote in the order that “the growth component adds money to the base number in exactly the same way that interest adds money to a traditional loan’s outstanding principal.”
Better Future Forward told students in multiple places on its application and disclosure forms “THIS IS NOT A LOAN,” the CFPB said, which the agency found deceived borrowers.
Kevin James, Better Future Forward’s chief executive officer, wrote in an email that the organization’s program is making a difference for its students and other “tremendous ISA programs” are seeing similar results. James added that despite uncertainty surrounding the regulatory treatment of ISAs, the organization has used disclosures built around the principles of existing laws.
“With the Bureau’s determination, we are eager to work with them to bring clarity to the question of how existing federal disclosures should apply to ISAs,” James wrote. “We will also continue to work with policymakers more broadly to get a more comprehensive consumer protection regime in place that addresses the unique nature of these new tools.”
Companies doing similar things are likely ‘on notice’
As part of the agreement, the CFPB didn’t impose a financial penalty on Better Future Forward because the organization “demonstrated good faith and substantial cooperation beyond that required by law,” the Bureau said in a press release.
But going forward, other providers will likely have to find a way to offer their products while complying with the position sketched out by the CFPB in the order, said Dalié Jiménez, a professor at University of California Irvine’s School of Law. That means issuing disclosures and not describing the product as something other than a loan.
“To the extent that you’re a company that is engaging or has engaged in any of the listed things,” she said. “You are definitely on notice.”
Following the expectations the CFPB laid out in its consent order, like providing certain disclosures, won’t stop ISA providers from giving ISAs, Earley said.
But the signal from the CFPB that the Bureau views them as credit could mean, according to Levitin, that ISA programs have to follow the Equal Credit Opportunity Act, which prohibits discrimination on the basis of race, sex and other categories. That is “a real problem for ISAs, particularly ISAs that are being offered not just for a single program, like a coding camp or something, but where they are being offered generally to a higher education population,” he said.
Critics of ISAs have warned that the way some are structured could mean they’re discriminating against certain protected groups. Some schools and ISA companies offer the deals to students in a variety of majors. Typically, students majoring in a higher earning field will be asked to pay back a smaller percentage of their income than students pursuing majors with less earning potential.
Fields that pay more tend to be disproportionately white and male, which means women and students of color are more likely to end up with ISAs that have more onerous terms. “There’s a looming fair lending problem if ISAs are credit,” Levitin said.
Department of Education will consult with colleges offering ISAs
The order, which described ISAs as private student loans, may also present challenges for colleges offering ISAs for another reason: There are specific rules surrounding the way colleges can interact with private student lenders.
Right now, some colleges do offer income share agreements to students themselves, pitching the deals as an indication that the schools have a stake in students’ success — if a student makes less money, the college gets paid back less. Typically, schools work with a company that collects payments and provides back end support for the agreements in other ways.
Colleges that endorse a certain private loan product have to publicly document why they’re making that endorsement and can’t share revenue with the loan company. The Department of Education indicated that it would be looking at whether colleges that offer ISAs are following these guidelines, known as preferred lender rules.
“The Department is committed to making higher education more accessible and affordable and supporting good practices that protect loan borrowers so students don’t graduate under mountains of debt,” a Department of Education spokesperson said in a statement. “The Department plans to consult with the CFPB to better advise colleges that endorse ISAs and are required to comply with preferred lender rules.”
This regulatory debate is part of a larger trend
Though income share agreements occupy a seemingly wonky corner of the education finance sphere, the debate surrounding their regulatory treatment is reminiscent of others taking place in the financial services space, Levitin said.
For example, questions have swirled around whether earned wage access products, which allow employers to give workers a portion of their earnings before they receive their paycheck, are debt. Recently, Coinbase
a cryptocurrency platform, said the Securities and Exchange Commission was investigating the company over a lending product that the regulator says could qualify as a security.
“The whole ISA thing is part of a larger trend we’re seeing right now of innovation in financial products where the companies that are innovating are claiming that their product doesn’t fit into an established regulatory category,” Levitin said. “It’s not clear in any of these cases that the products are actually so different that they can not and don’t fit into the current framework.”
In the case of ISAs, Earley said the CFPB “is the right regulator on the federal level to be looking at these instruments.” Still, she said there are areas where the products don’t fit neatly into regulations governing loans.
ISA providers “want clarity, they want to know what the rules are,” Earley said. “All of the existing consumer protection laws could be applied to ISAs, but there are important places where the requirements under these laws have to be translated for ISAs because they’re functionally different than loans.”
For example, calculating an APR on an ISA may not be as straightforward as on loan products, she said. Without guidance, different providers will calculate it differently, Earley said.
For Jiménez, the different terms of an ISA aren’t enough to convince her it’s not a loan. “There are only so many categories, and I suppose in theory you could invent some other category, but this seems to fit the categories that we have,” she said.
“Just because the repayment is complicated — meaning there are all these ways in which you pay back more or less — you’re still asking for people to have an obligation to repay,” Jiménez said.